Standard and Poors have upgraded Irish government bonds from BBB to A- with positive outlook. Their statement justifying the upgrade is below the fold.
OVERVIEW
- We have revised our 2014-2016 average real GDP growth projections for Ireland upward to 2.7% from 2.0%.
- This reflects our expectation of a continued strong external performance and a sustained recovery of the domestic economy.
- We are therefore raising our long-term sovereign credit ratings on Ireland to 'A-' from 'BBB+'. We are affirming the short-term ratings at 'A-2'.
- The outlook is positive, reflecting our view of at least a one-in-three possibility that we could raise our ratings on Ireland again in the next
two years.
RATING ACTION
On June 6, 2014, Standard & Poor's Ratings Services raised its long-term foreign and local currency sovereign credit ratings on the Republic of Ireland to 'A-' from 'BBB+'. At the same time, we affirmed the short-term ratings at 'A-2'. The outlook is positive.
RATIONALE
The upgrade reflects our view of the brightening prospects for Ireland's domestic economy, which we expect to underpin further improvements in the government's financial profile, capital markets access, and financial system asset quality. We also note the €3 billion prepayment of senior debt by National Asset Management Agency (NAMA), Ireland's publicly owned bad bank, which we include in the general government sector. From repayments of €10.5 billion to date, we anticipate that NAMA will increase the pace of bond redemptions this year. This raises the possibility of a faster decline in levels of general government debt to GDP.
In 2013 alone, Ireland attracted high inflows of foreign direct investment (FDI) totaling €26.7 billion, or 16% of GDP. Much of this FDI financed the labor-intensive service sector, which has been posting sustained competitiveness gains. We expect FDI to bolster Ireland's real GDP growth performance, which we now believe will average 2.7% over 2014-2016.
Since 2008, Ireland's flexible labor and products markets have facilitated a correction of the 2005-2008 overshoot in nominal wage and price levels. As a consequence, unit labor costs have dropped by an estimated 21% back to 2005 levels--the strongest adjustment in the eurozone with the exception of Greece. Since 2005, labor productivity per hour worked has risen by 5%, in line with the eurozone average, while Ireland's export share in global trade continued to expand.
The real effective appreciation of the euro since mid-2012 and a deterioration in Ireland's terms of trade have so far not undermined its external performance: Ireland's current account surplus rose to 6.6% of GDP in 2013 from 1.3% in 2011. We project that Ireland's current account surpluses will average close to 6% of GDP through 2017, as rises in services exports outpace goods exports. Offsetting these flows, the income deficit continues to be sizable and highly sensitive to the timing of dividend and interest payments on Ireland's high external liabilities.
While lower-than-previously-expected GDP growth in 2013 reflected weaker pharmaceutical sector production and exports (due to major patent expirations), the domestic economy gained traction with gross national product (GNP) expanding by 3.4%. (GNP adds to GDP the net balance of income accruing to domestic residents minus the income that nonresidents earn from their investment in Ireland. In Ireland's case, GNP is one fifth smaller than GDP given the large stock of inbound FDI.)
We believe the domestic recovery is broadening and has gathered pace in the first quarter of 2014. Full-time employment grew by 2.3% from the 2013 March quarter to the 2014 March quarter, with the unemployment rate estimated to have declined to 11.8% in May 2014, the lowest since April 2009.
We also link our expectation of improving budgetary performance to strengthening domestic economic conditions, as well as Ireland's track record of meeting its stated fiscal goals since entering into an EU/IMF program in 2011. The government completed this program in December 2013 and will amortize this official debt over the next 30 years. In 2014, we expect the general government deficit to be about 5.1% of GDP, on the back of spending control and, to a lesser extent, out-performance of tax receipts.
We expect net general government debt to peak at 127% of GDP in 2013 (partly reflecting a strong cash buffer) and to decline to 112% by 2017. Our estimate of Ireland's gross and net general government debt includes NAMA obligations issued to purchase loans and other distressed assets from participating Irish banks at a discount to market value. They amount to 19% of GDP. Although we consolidate NAMA's debt into general government debt, we do not consider NAMA's assets, apart from cash and cash equivalents, as liquid. Should NAMA convert its loan assets into cash through foreclosure or sale more quickly than we expect, Ireland's general government debt net of liquid assets could commensurately decline faster than we project.
The consensus among most of the country's larger political parties--in favor of fiscal consolidation and policies aimed at promoting economic flexibility, competitiveness, and openness--supports Ireland's policy and institutional effectiveness. The 2008/2009 recession revealed shortcomings in this regard. In our opinion, these shortcomings have mostly been addressed through regulatory and legal reforms, under the IMF/EU bailout program.
While external performance has improved, our complete assessment of Ireland's external risks is hampered by transaction flows and asset and liability stock inconsistencies on the external side. This reflects a possible overstatement of current account receipts due to transactions by nonresident companies that are domiciled in Ireland for tax purposes; if these companies were to re-domicile elsewhere, this would likely reduce the current account surpluses.
Regarding the stock of Ireland's external position, the large asset and liability positions of international financial services companies (IFSCs) operating in Ireland create similar analytical complexities. At end-December 2013, IFSCs accounted for 93% of all Ireland's total foreign assets and 93% of Ireland's total foreign liabilities. Valuation of these assets and liabilities
can lead to large discrepancies between Ireland's balance-of-payments flows and net external debt stock measurements on a cash basis.
The government's international capital markets access has improved and the maturity extension of its European Financial Stability Facility and European Stability Mechanism official debt, agreed earlier in 2013, has reduced its short-term financing needs. The government's large cash buffer--equivalent to
10.7% of GDP at year-end 2013 or all its remaining 2014 gross borrowing requirements--has supported this. During 2013, several Irish banks returned to commercial financing via sales of unsecured debt. The Bank of Ireland notably used the proceeds of its issuance to redeem €1.8 billion of its preference shares held by the government. Given the uncertainties related to global liquidity, however, we view Ireland's private-sector access to external funding as still tenuous.
We observe that employment growth is coinciding with a gradual decline in long-term mortgage arrears. We estimate nonperforming loans (NPLs; more than
90 days past due) in the Irish financial sector at a very high 35% of domestic loans compared to Portugal (about 13.5%) and Spain (about 19%). While some lenders are reporting the total stock of NPLs as falling, we expect this process will be slow. To date, the highest levels of NPLs have been recorded in commercial real estate. These NPLs are well provisioned, however. We expect NPLs in the small and midsize enterprise sector--typically in the 25%-40% range--to decline slowly.
Our main concern relates to banks' mortgage books. According to industry data at March 31, 2014, a high 13.7% of all mortgage accounts were more than 90 days past due. Moreover, if we include cases that are in forbearance and not in arrears (that is, repayments have been temporarily postponed or restructured), as well as those that are less than 90 days past due and properties in possession, then a very high 26.5% of all mortgage cases are in some form of difficulty.
Nevertheless--prompted by the regulator--the banks have developed their loan work-out capabilities. Combined with government legislation that removed legal obstacles to repossession, a new personal insolvency regime that is now up and running, and a revised code of conduct that governs how lenders must treat struggling mortgage borrowers, this suggests banks will soon be better placed to address the asset quality of their mortgage book through foreclosure, rescheduling, or other remediation.
Although individual Irish bank capitalization is currently weak or barely moderate by our measures, we assess contingent liabilities from the financial sector as limited, under our criteria, given the thoroughness of the Irish banking system's restructuring in the last five years.
OUTLOOK
The positive outlook reflects our view of at least a one-in-three possibility that we could raise our ratings on Ireland again in the next two years. An upgrade could result from additional data confirming that Ireland's economic recovery is well-entrenched and that its fiscal deficits have narrowed to well below 3% of GDP. We also would expect Ireland's major banks to take additional resolute steps to address asset quality, including continued provisioning and
loan write-offs.
On the other hand, the ratings would stabilize if the Irish economy returned to weaker economic performance, government debt reduction slowed, or if banks' asset quality did not improve from current weak levels.
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